2023-11-29 20:44:33 ET
Summary
- Synopsys has been one of the hottest tech stocks this year as well as the past decade, delivering stunning returns.
- Synopsys has shown a rare combination of double-digit revenue growth alongside robust GAAP profitability.
- The company is a "picks and shovels" play for the growing generative AI sector.
- I must reiterate my "avoid" rating in spite of the high fundamental quality.
Synopsys ( SNPS ) is one of the hottest tech stocks in the market today. Benefiting from not only an overall tech recovery (in which SNPS barely dipped relative to peers) as well as its association with generative AI, SNPS has delivered 60% returns year to date. The company has achieved solid double-digit topline growth alongside solid GAAP profitability. SNPS has a net cash balance sheet and is repurchasing shares. The company is undoubtedly of high quality but I question whether the current valuation offers an attractive entry point. The stock is pricing in many years of growth, making it hard to imagine a scenario in which it outperforms the broader market unless we apply aggressive assumptions. I expect SNPS to be a beneficiary of the growth of generative AI but all of that optimism is priced in - and more. I reiterate my view that one should avoid the stock and search deeper for value in the tech sector.
SNPS Stock Price
SNPS is seemingly one of the few tech names that's trading at all-time highs. The stock didn’t get hit so hard during the 2022 tech crash, perhaps due to its GAAP profitability, and has experienced a multiple re-rating upwards due to generative AI interest. This is a stock that has delivered 5x returns over the last five years and around 14x returns over the last decade.
I last covered SNPS in August, where I initiated coverage on the name and gave it a neutral rating due to valuation. The stock has soared more than 25% since then, but recent results have not changed my view that the optimism is overdone.
SNPS Stock Key Metrics
In the most recent quarter, SNPS delivered 25% YoY revenue growth to $1.599 billion, enabling it to achieve $5.843 billion in fiscal-year revenue, coming in above the high end of guidance. The company generated $2.26 in GAAP EPS and $3.17 in non-GAAP EPS, also ahead of guidance. SNPS is one of the rare tech companies showing double-digit revenue growth alongside healthy GAAP profitability.
SNPS ended the quarter with $1.6 billion in net cash. The company has chosen share repurchases as the primary use of free cash flow - the company repurchased almost exactly $300 million in stock in every quarter this year.
Management has guided for up to 13.5% YoY revenue growth to $6.63 billion and 19.8% YoY earnings growth to $13.41 per share in the upcoming year, both ahead of consensus estimates. Management expects non-GAAP operating margins to expand from 35.1% to 37% for the full-year.
Is SNPS Stock A Buy, Sell, or Hold?
It's not too surprising that SNPS has continued to deliver strong results in such a tough macro environment. Besides the fact that enterprise tech companies have in general posted resilient results due to their recurring revenue models, SNPS has positioned itself in fast-growing sectors in which it has market leadership.
SNPS is most well-known for its electronic design automation (‘EDA’) prowess - SNPS sells software to semiconductor companies like Nvidia ( NVDA ) which is used to design chips. There's a lot of truth to the notion that SNPS is a “picks and shovels” play on the growth of generative AI.
Over the long term, management has guided for annual double-digit revenue growth (I expect price increases to be a significant contributor to this point moving forward), 100 bps of annual non-GAAP operating margin expansion, and mid-teens annual non-GAAP EPS growth.
There’s a lot to like here - maybe too much - and Wall Street has rewarded the stock with premium valuations. The stock recently traded hands at a nosebleed 49x earnings (non-GAAP earnings).
Consensus estimates call for the company to sustain low double-digit revenue growth over the next few years.
It's difficult to call SNPS a “bubble” given that this is a company with market leadership generating nearly $6 billion in annual revenues alongside 21% GAAP net margins. However, the valuation looks very stretched in my humble opinion. If we assume that the stock trades at a 1.5x price to earnings growth ratio (‘PEG ratio’) in 2027 and is able to generate 40% net margins over the long term (consensus estimates call for 32% net margins in 2027), then I could see the stock trading at around 7.2x sales in 2027, implying some downside over the next four years (there's also about 2% in earnings yield that can help the annual return proposition). If I instead expect the company to trade at a 2.5x PEG ratio and generate 45% long-term net margins, then my target rises to 13.5x sales, implying around 11.2% annual return potential (or around 13% inclusive of the earnings yield), which would likely be enough to outperform the market. However, the math exercise above has indicated that the stock must command a premium valuation in order for the investment to be worthwhile relative to the broader market. I point out that there are not many mature tech companies that still trade at above 10x sales - Microsoft ( MSFT ) may be one lone exception.
There are many potential reasons to like SNPS stock, but the math unfortunately just does not work out. Unless one believes that growth will accelerate meaningfully (which seems unlikely given the substantial revenue base and predictable growth model) or that the stock will trade meaningfully more expensive moving forward, I find it likely that the stock delivers unsatisfactory returns, and highly likely that it underperforms the broader market. I reiterate my “avoid” rating on the stock as investors can do better elsewhere.
For further details see:
Synopsys: Generative AI Stock Is Rising, But There's A Problem